Scribd
Upload
12 views

PRACTICE

The document contains 5 questions about calculating return on investment (ROI), residual income (RI), and net present value (NPV) for various divisional investment proposals. It provides financial data for multiple divisions and asks the reader to calculate ROI and RI both with and without proposed investments to evaluate the proposals.

Uploaded by

Thị Ngọc Châu Cao
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
12 views

PRACTICE

The document contains 5 questions about calculating return on investment (ROI), residual income (RI), and net present value (NPV) for various divisional investment proposals. It provides financial data for multiple divisions and asks the reader to calculate ROI and RI both with and without proposed investments to evaluate the proposals.

Uploaded by

Thị Ngọc Châu Cao
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
You are on page 1/ 4

Question 1

A divisionalised organisation has a target ROI of 15% for all divisions,


based on the book value of divisional assets, to reflect its cost of capital.

One of the divisions is considering whether to undertake Project Q. The


required asset investment will be £100,000. The assets will have a
useful life of four years and a residual value of zero. The company
depreciates its assets using the straight-line method. Profits for Project
Q before depreciation has been accounted for are forecast at £36,000
per annum over the life of the assets.
Should the division go ahead with Project Q?
Calculate ROI, RI & NPV to evaluate the proposal.
(present value of £1 received each year for 4 years at 15% is £2.855)

Question 2
The Henson Group’s Muppet Division recently reported the following:

£000
Sales revenue 2,500
Contribution 1,500
Profit before depreciation 1,100
Capital assets 5,000
(Depreciation currently charged is £600,000 per annum)
The Group's cost of capital is 12%
What was the Division's ROI% for the period?
A 30%
B 20%
C 10%
D none of the above
What was the Division's RI for the period?
A (£100,000)
B £900,000
C £300,000
D none of the above
Question 3
Fresno plc is divided into a number of operating divisions, each of which is run as an
autonomous investment centre. The group’s average cost of capital is 7% and its
average return on investment (ROI) is currently 15%.

The company bases ROI calculations on asset values at the start of the financial year.
All fixed assets are depreciated on a straight-line basis. Budgeted data for the year
ending 31st December 2020 are available for four of the company’s divisions as
follows:

Division Net Assets (Jan 1st) Operating Profit Sales


£000 £000 £000

A 600 150 1700


B 900 275 2600
C 550 140 1600
D 400 50 420

The following transactions are proposed (all with effect from 1st January 2020):

1. Division A: investment of £200,000, forecast to yield sales of £300,000 and


operating profit of £40,000 per annum.

2. Division B: disinvestment of assets with a book value of £160,000; if retained,


they are budgeted to earn a profit of £35,000 during the period.

3. Division C: sale of a product line at book value of £50,000. This line is


budgeted to earn a profit of £40,000 during the period. It will be replaced by
investing £200,000 in a new line that will yield a profit of £60,000 per annum.

4. Division D: investment of £160,000, forecast to yield sales of £70,000 and


operating profit of £22,000 per annum.

Required

a) For each division, calculate budgeted ROI and residual income:


(i) based on the original budgets;

(i) based on the budgets plus the effect of the proposed transactions.

Discuss the use of ROI and RI in measuring divisional performance in the


context of your results in (a).
Question 4:
The Media Group has 3 major divisions, whose results for 2018 and 2019 (all £m.) are
given below.
Newspapers TV Film
Sales revenue £m £m £m
2018 4500 6000 1600
2019 4600 6400 1650
EBIT (after depn)
2018 900 130 220
2019 1100 160 200
Total assets
2018 4400 2700 2500
2019 4900 3000 2600

Divisional managers have an annual bonus plan based on the average ROI achieved.
The company’s cost of capital is 12%.
The manager of the Newspapers division is considering a proposal to invest £200m in
new technology. It is estimated that this investment will result in the 2020 EBIT
increasing by £30m.
Calculate the ROI for each division for both years and comment on the results.
Why might the Newspapers manager be less than enthusiastic about the
investment proposal?
Calculate the RI achieved by each division in 2019.
Would the adoption of RI reduce the manager’s reluctance to invest in new
technology?
Question 5
Robin Ltd is a subsidiary of a large multinational and operates as an investment
centre. It has an operating profit of £30,000 and operating assets of £150,000.
Its cost of capital is 15%. There is a proposed investment of £15,000 which
should increase the operating income by an estimated £1,900.
Calculate the return on investment before and after the proposed
investment.
Calculate the residual income before and after the proposed investment.
State whether the following are true or false:
If a manager’s performance is being evaluated, a portion of head office assets
should be included in the calculation of the centre’s ROI.
The use of ROI may lead to short termism.
There is a danger that the division’s manager may make decisions that are not
good for the company as a whole.
Senior management of the group should be involved in the day to day decision
making within the division.
Which two of the following would increase the ROI:
Increase payables, reduce interest payments, accept all projects with a positive
NPV, keep old machinery

You might also like